Similarly, Patrick Olivelle (2005, p 47) remarks, ‘Given the problems inherent in the dating of these two texts, it is not possible to assert with high degree of confidence who is borrowing from whom. I do agree with Kangle, however, that it is most likely that at least sections of the Arthashastra are older than Manu and are the source for some of the passages and vocabulary I will discuss below.’
3. Patrick Olivelle (2005, p 39) comments, ‘A major aim of Manu was to reestablish the old alliance between brahma and ksatra, an alliance that in his view would benefit both the king and the Brahmin, thereby reestablishing the Brahmin in his unique and privileged position within society.’
4. For an excellent survey on social norms see McAdams, Richard H and Eric Rasmusen (2005).
5. M Stuart Madden (2005, p 835) observes, ‘Ordinarily, early codes reflected efforts to gather, rationalize, and organize already extant customary law. For all that is apparent, Hammurabi himself intended that his law reconciled wrongs and bring justice to those aggrieved. His unmistakable goal was the economic stability and enhancement of the people.’
6. For a much deeper understanding of this distinction and many others, see Benjamin Zipursky (2008). For example, he (p 106) observes, ‘Wrongful injuring of another and violations of regulatory rules designed to ensure that people drive in non-injurious ways are both responded to in the law, but are responded to in different ways: the former by an individual plaintiff through tort law, the latter by the state through regulatory (or traffic) law. The moral luck problem in tort law stems, in part, from the failure to appreciate the differences between these two different modes of response within the legal system—tort liability being a holding responsible for a breach of duty of non-injury, and regulatory liability being a holding-responsible for a breach of a duty of non-injuriousness.’
7. I am grateful to Prof Peter Diamond for this formulation. Assume penance is additive to utility from consumption and measured in utility terms the utility function is:
U= u (I–F)–P
Where I= income, F= fine, and P= penance.
An indifference curve satisfies
P= u (I–F)–U
dP/dF=–u'<0
And
d2P/dF2= u"<0
That is, the indifference curve for two bads is concave.
8. Guido Calabresi (2007, p 5) observes, ‘Compensation to the victim was not a necessary part of it. And indeed, tort-like remedies that existed around the same time may not have contemplated compensation at all. The Hundred (the neighbourhood) was assessed if a thief was not caught. The Hundred was charged the amount of the thievery. But this amount didn’t necessarily go to the person whose property had been stolen. Compensation was not the essence of what was going on. It was not a matter of somebody’s right to recover. It was system-building, not corrective justice.’
It may be added that when a corporation is penalized, all the stakeholders may share the burden and it may be called a Thousand instead of a Hundred. Similarly, Hylton and Miceli (2005) conclude, ‘There appears to be no case for multiplying damages in order to guarantee reasonable care in the medical malpractice context.’ Again, in response to higher malpractice awards, physicians are likely to resort to defensive medical practices and ultimately the cost might get shifted to the consumers through high health insurance premia.
9. Prue Vines (2007, p 15) observes, ‘Apologies can be part of this corrective justice mix if one considers compensation as practical reparation and apology as reparation for the emotional and moral pain suffered for the victim.’ He adds, ‘Similarly, an apology might be a mechanism which reinforces the moderation of damages, on the basis that the noneconomic parts of the award, such as that for pain and suffering, might be better repaired by an apology than award of money.’
10. Coleman (2003) explains it very aptly as: ‘The rule of fault liability is efficient in the two party case in that it induces both injurers and victims to make optimal investments in safety. The rule of fault liability imposes on the injurer only if he is fault. If the injurer is rational, he will always take the cost justified precautions. We established this result above in the discussion of the one party accident case. Thus, the rational injurer will never be at fault. If people are always rational, then the costs of whatever accidents occur will fall to their victims.’
11. Ayesha (2010, p 2) points out, ‘Defamation is a unique tort, especially when understood in its historical context. Until the 16th century in England, general jurisdiction over defamation was exercised by the clergy. Thereafter, the common law courts developed an action on the case for slander where ‘temporal’, as distinct from ‘spiritual’ damage could be established. This progress became too rapid for the judges who proceeded to hedge the action around with tighter restrictions. Later, the common law courts established a distinction between libel and slander on the basis that damage could be presumed in libel, but that the plaintiff would have to prove ‘special damage’ before an action for slander would lie.’
12. M Stuart Madden (2005, p 832) observes, ‘Withal, even though the sources of contemporary civil law have changed, the needs of modern society for a similar order and predictability in human civil affair remain very similar to the needs confronting our ancestors.’
CHAPTER -18 1. Surprisingly, Adam Smith had very similar views on foreign rule. Letiche (1960, 72) states, ‘The Government of India, Smith wrote, was composed of a council of foreign merchants. “The plunderers of India”, he called them in one passage, “military and despotical”, in another.’
2. Alternatively this may be specified as:
DE1 = α0 +α1 Y1 + α2 DE2 (18.3)
DE2 = β0 +β1 Y2 + β2 DE1 (18.4)
Where DE1 and DE2 are respective expenditures on defense and Y1 and Y2 are the respective incomes of the two countries. According to Kautilya, national security depended not just on how much a nation spent on her defense but also how much a potential adversary spent on defense.
3. According to Tversky and Kahneman (1991), the value function has three characteristics: ‘Reference dependence: the carriers of value are gains and losses defined relative to a reference point. Loss aversion: the function is steeper in the negative than in the positive domain; losses loom larger than corresponding gains. Diminishing sensitivity: the marginal value of both gains and losses decreases with their size. These properties give rise to an asymmetric S-shaped value function, concave above the reference point and convex below it.’
4. According to Tversky and Kahneman (1979), ‘Any discussion of the utility function for money must leave room for the effect of special circumstances on preferences. For example, the utility function of an individual who needs $60,000 to purchase a house may reveal an exceptionally steep rise near the critical value. Similarly, an individual’s aversion to losses may increase sharply near the loss that would compel him to sell his house and move to a less desirable neighbourhood.’ Kautilya’s approach would be better in this case since the price of the house is not fixed and could rise or fall, implying the use of the ratio of current assets to target assets would be more appropriate.
5. Tversky and Kahneman (1991) remark, ‘Although the reference state usually corresponds to the decision maker’s current position, it can also be influenced by aspirations, expectations, norms, and social comparisons.’
6. See the discussion on tort liabilities in the preceding chapter. Kautilya discussed many tort liabilities, such as accidents, defamation, malpractice etc. at length. Urbanization had [led] to the opening up of many types of services, including laundry services. Due care required washing cloth on a smooth surface stone, otherwise the washerman was liable for a tort liability.
Building Codes: Kautilya recommended building codes to protect privacy. He (p 371) wrote, ‘The doors and windows shall be so made as not to cause annoyance by facing directly a door or a window of a neighbouring house. Any window made for lighting shall be high up [so that it does not overlook a room of another house] (3.8).’
&n
bsp; Penalties for tossing dirt in the road: Boesche knows that there is a fine if a person throws anything on the road. Pollution is a negative externality. If left to people or businesses, they would pollute the rivers, lakes and the environment. Aristotle and Adam Smith talk about externalities but Kautilya provided a solution also to handle it, a kind of corrective fine or a fee. This is explained in Chapter 16 on property rules and contract laws.
CHAPTER -19 1. Johnston (2000) notes, ‘Risk taking, for example, had a long tradition before the advent of studies in the mathematics of probability. The Babylonians had had forms of maritime insurance; the Romans had annuities (exchanges of a lump sum in return for regular payments over a long time—the risk being that the person taking out the annuity will not live to collect the lump sum); and gambling had existed since time immemorial.’
However, Markowitz’s (1952) two insights are noteworthy. (i) ‘The portfolio with maximum expected return is not necessarily the one with minimum variance. There is a rate at which the investor can gain expected return by taking on variance, or reduce variance by giving up expected return.’ (ii) ‘In trying to make variance small, it is not enough to invest in many securities. It is necessary to avoid investing in securities with high covariances among themselves.’
2. Similarly, according to Friedman and Savage (1948), Adam Smith and Marshall did not say much on portfolio theory. They note, ‘These problems have, of course, been considered by economic theorists, particularly in their discussions of earnings in different occupations and of profits in different lines of business. Their treatment of these problems has, however, never been integrated with their explanation of choices among riskless alternatives.’ They comment on the incoherent views of Alfred Marshall and Adam Smith on explaining behavior towards risk. They assert, ‘Choices among alternatives involving different degrees of risk, for example, among different occupations, are explained in utterly different terms—by ignorance of the odds or by the fact that “young men of an adventurous disposition are more attracted by the prospects of a great success than they are deterred by the fear of failure”, by “overweening conceit which the greater part of men have of their own abilities” by “their absurd presumption in their own good fortune”, or by some similar deus ex machina.’
3. Johnston (2000) points out, ‘In keeping with the legal traditions of his time, Pascal's emphasis here is on expectation and equality between the two players, the central point of his analysis, rather than on the calculation of the probability outcomes and their associated values (2). Hence, he eliminated probability from as much of the problem as possible, using certain gain and equity in its place (3).’ He quotes Daston: ‘Once again the modern order of reasoning regarding expectations was inverted: instead of the game being fair because the probabilities (and therefore the expectations in a symmetric game) are equal for all players, the probabilities are (implicitly) equal because the game is assumed [to be] fair–and the game is fair because the conditions of the players are indistinguishable, as shown by their willingness to exchange expectations (Daston 26).’ He comments on the tension between reasonableness and prudence, exposed by the Petersburg Paradox. He observes, ‘The assumption here that reasonable behaviour (the conduct of the prudent intelligent person) was a universal standard, which matched mathematical calculations of expectations was a widespread belief in the 18th century and persisted well into the 19th. This slight (although very well known) example illustrated a tension between equitable games and prudent behaviour. Equity would seem to demand a large stake from A (since the potential risk for B is high indeed), and yet, if A is reasonable, prudence would seem to insist upon a relatively small stake.’
Similarly, Wit (1997) explains it well, ‘What the St Petersburg Paradox shows us is that the there is no inherent connection between mathematics objects and rational action. The Paradox only exists as a paradox if one believes that such a connection does exist. That Daniel Bernoulli understood this fact clearly demonstrate his definition of moral expectation as an attempt to model human moral intuitions in response to the Paradox. He argued that any gain is less than proportionately related to moral enjoyment (whereas damage possesses a more than proportional relationship). According to this moral expectation a rational (where rational is taken to be the same as acting in accordance with moral expectation, by definition) person would pay at most $1 for the game.’
4. Varian (1993) noted that Friedman gave a hard time to Markowitz in defense of his thesis on portfolio balancing as a part of economics. Interestingly, Markowitz concedes the point.
5. Although Adam Smith was also worried, at least, about an underestimation
of the probability of a loss, he did not incorporate it into any decisionmaking. Adam Smith (p 209-210) remarked, ‘The chance of gain is by
every man more or less over-valued, and the chance of loss is by most
men under-valued.’
6. Varian (1993) points out, ‘Even Keynes (1939) said, “To suppose that
safety-first consists in having a small gamble in a large number of different
companies strikes me as a travesty of investment policy.”’ 7. Interestingly, Daniel Bernoulli (1738) remarked, ‘It also follows from this
that a man who risks his entire fortune acts like a simpleton, however
great may be the possible gain.’ However, there was one significant
difference. Despite the unavailability of the concepts of variance and
covariance, the other developments in mathematics allowed him to show
the gains from diversification and thus offer a genuine positive analysis. 8. Rubinstein (2002) remarks, ‘Markowitz can boast that he found the
field of finance awash in the imprecision of English and left it with the
scientific precision and insight made possible only by mathematics.’
CHAPTER -20 1. A Brief Summary of the State of the Game Theory: Until the seventies, control-theoretic approach was primarily used in economic analysis related to policy-making. On the other hand, during the seventies and the eighties, the focus shifted to the game-theoretic approach. However, now, both, the control-theoretic and game-theoretic approaches, are combined since both are essential ingredients of a sound economic policy. At one point, it appeared as if game theory was the only game in economic theory, since its scope appeared much broader than what actually turned out to be. The existence of multiple equilibria reduces its potential applications and similarly, the existence of multiple approaches, which advance conflicting goals of game theory, is not helping either. Axiomatic Approach to Game Theory: Recently, in honoring the Nobel Prize winning contributions of Nash, Selten and Harsanyi, Gul (1997) remark[s], ‘In the 1980s, armed with models of asymmetric information, dynamic strategic interaction and insights from the information economics of the 1970s, economists developed truly game-theoretic models of industrial organization.’ He adds, ‘However, perhaps the biggest impact of game theory has been on what one might call pure theory; that branch of economics that focuses on developing tools and investigating the foundations of economic analysis.’ Game theory has provided many insights into many fields. For example, it is complementing price theory in resolving the old indeterminacy of bilateral monopolies.
Varian (1992, p 282)) concludes his exposition of the game theory as ‘Nash equilibrium, in its original formulation, puts a consistency requirement on the beliefs of the agents—only those beliefs compatible with maximizing behavior were allowed. But, as soon as we allow there to be many types of players with different utility functions, this idea loses much of its force. Nearly any pattern of behavior can be consistent with some pattern of beliefs.’ It would appear that there are strong diminishing marginal returns to further refinements.
Behaviorist Approach to Game Theory: The above axiomatic approach is not universally accepted. The behaviorist school believes that the game theory should study the actual behavior of the individuals, and not the rational behavior. Camerer (1997) asks, ‘Is
game theory meant to describe actual choices by people and institutions or not? It is remarkable how much game theory has been done while largely ignoring this question.’ He adds, ‘At one extreme, highly mathematical analyses have proposed rationality requirements that people and firms are probably not smart enough to satisfy in every day decisions. At the other extreme, adaptive and evolutionary approaches use very simple models—mostly developed to describe nonhuman animals—in which players may not realize they are playing a game at all. When game theory does aim to describe behavior, it often proceeds with a disturbingly low ratio of careful observation to theorizing.’
Evolutionary Approach to Game Theory: On the other hand, Mailath (1998) concludes, ‘However, on the positive side, important insights are still emerging from evolutionary game theory (for example, the improving understanding of when backward induction is appropriate and the formalization of strategic uncertainty). Interesting games have much equilibrium, and evolutionary game theory is an important tool in understanding which equilibria are particularly relevant in different environments.’
At present, these alternative approaches are advanced to handle strategic interactions and the challenge is to weave them into one coherent theory in which actual behavior may be allowed to deviate from the rational behavior and the evolutionary process used in restoring uniqueness.
2. The Recent History of Time Inconsistency Problem: The seminal work by Kydland and Prescott (1977) has ignited the current debate on rules versus discretion. According to the rational expectations school, current decisions are influenced by the perceived future policies. However, optimal control theory does not allow such anticipatory behavior. They conclude, ‘There is no way control theory can be made applicable to economic planning when expectations are rational.’ Since then, the problem of reneging or credibility has moved to the center stage. In particular, the credibility of the monetary authorities has come under strict scrutiny. A Central Bank may resort to expansionary policies to reduce temporarily the unemployment rate below the natural rate of unemployment, thus causing excessive inflation without any longterm gain in employment. It has been argued that in the absence of pre-commitment, whatever monetary policies are announced initially could be revised later due to a temptation to avail of new opportunities. Numerous suggestions have been offered to achieve a socially desired rate of inflation, such as, appointing a Central Bank Governor or chairman who has a reputation of being conservative (Rogoff, 1985), and linear inflation contracts (Svensson, 1997).
Kautilya- the True Founder of Economics Page 42
